BOE says smooth Brexit could mean faster UK rate increases

The Bank of England has suggested that there will be a tightening of the monetary policy in the event of a smooth exit from the European Union.
The Bank of England has suggested that there will be a tightening of the monetary policy in the event of a smooth exit from the European Union.PHOTO: REUTERS

LONDON (BLOOMBERG) - The Bank of England said it may need to raise interest rates faster than the market suggests, assuming that Brexit goes well.

While it didn't say what deal would be best for the United Kingdom, its latest forecasts are based on the assumption that the adjustment to a new relationship with the European Union is "smooth". That means avoiding the so-called cliff edge where the UK leaves after the two-year negotiation period without transitional arrangements in place.

If the economy grows as expected, "then monetary policy will need to be tightened by a somewhat greater extent over the forecast period than the very gently rising path implied by the market yield curve underlying the May projections," the Monetary Policy Committee said on Thursday in London.

It made the assessment alongside its latest policy decision and updated economic forecasts. The panel kept the benchmark interest rate at a record-low 0.25 per cent, though Kristin Forbes dissented again, voting for an immediate increase. Others on the committee said it may not take much upside news for them to switch to her position.

In a quarterly update, officials cut their forecast for growth this year to 1.9 per cent from 2 per cent, though they raised it for the following two years and said expansion will remain around trend over the period.

Growth slowed to 0.3 per cent in the first quarter, the weakest in a year, though the bank expects the figure to be revised up to 0.4 per cent. Forbes said the initial reading exaggerated the extent of the slowdown.

Reflecting the weaker pound, the MPC lifted its 2017 inflation projection to 2.7 per cent from 2.4 per cent, meaning a bigger overshoot of its 2 per cent target. The bank sees a slightly weaker path further out but expects inflation to be accelerating again at the end of the three-year forecast period. It also warned that domestic price pressures could be building at that time.

In addition to the crucial Brexit assumption, the latest forecasts are based on a rate increase not being fully priced in until the end of 2019. In February, the curve had priced in a hike by the first quarter of that year.

While inflation is set to reach 2.8 per cent by the end of 2017, the BOE is balancing its price concerns against the threats from Brexit and weak wage growth.

It expects almost no increase in real incomes this year and sluggish consumer spending, though that will be offset by investment and exports. Wages will pick up in 2018 and 2019 as unemployment falls and the output gap closes, which will increase domestic price pressures.

The insights from the Inflation Report are the first in weeks. The snap general election called by Prime Minister Theresa May put policy makers into purdah from the middle of last month. The MPC was short one member at this decision after Charlotte Hogg left the bank. She resigned after failing to disclose a potential conflict of interest.